Deutsche Bank says iron ore’s rock bottom price could be $US36 a tonne

Iron ore is the major cash cow for BHP and Rio and the big falls in the past month from about $US50 a tonne is heaping more pressure on cash flows. Photo: Carla Gottgens Deutsche’s AUD/iron ore pressure index has not yet reached levels that would worry the RBA.
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For those wondering where the iron ore carnage is going to come to an end, Deutsche Bank has a few suggestions.

The bank’s Australian chief economist Adam Boyton said $US36 a tonne is a likely floor for Australian producers and $US26 is an absolute floor. And with Australia being a low-cost producer, it’s likely these floors would apply globally as well.

On Saturday, Chinese steep production data showed crude steel output fell 1.6 per cent to 63.32 million tonnes compared with a year earlier. So far this year, production has dropped 2.2 per cent to 738.38 million tonnes. China makes about half of the world’s steel.

Iron ore was trading at a fresh 10-year low of just $US38.30 a tonne on Friday night. To put that in perspective, in 2011 it was trading at over $US180 a tonne.

“Different producers sit at different parts of the cost curve,” Mr Boyton told Fairfax Media.

At $US36, “that’s the point where if you were sustained under there for a while you’d start to lose the first chunk of Australian production”. At $US26, “most Australian production is uneconomic”.

“Australia is ‘the’ low cost iron ore producer, so if we’re uneconomic at those levels, why is anyone else producing?”

To sustain those levels would be “highly surprising”, said Mr Boyton, as it would require non-traditional uneconomic producers of iron ore to be still producing at significant volume.

“The prospect that that’s where you end up, and it’s ultimately Australian production that comes out of the market, is very small.”

It’s not just investors in mining stocks who are suffering from record low iron ore prices – taxpayers and those dependent on government spending will feel it as well, Mr Boyton said in a note this week, as taxation of mining companies is a significant source of revenue for state and federal governments in Australia.

“The biggest impact on an iron ore price in the high $US30s remains the implications for federal government finances,” Mr Boyton said.

“Much of the impact of lower commodity prices has been absorbed by the federal government via larger deficits and a higher level of net debt.”

Mr Boyton put the cumulative cost of lower iron ore prices between 2012-13 and 2015-16 at $175 billion – almost $7300 per Australian.

Lower commodity prices to 2018-19 will add another $60 billion to that amount.

“The hit to the real economy from lower commodity prices will come if the federal government decides it can no longer … continue to absorb this balance sheet pressure.”

However, “we don’t expect to be at that point for a few years yet”.

As to the surprising strength of the Australian dollar, which has pushed higher over the past weeks despite another dramatic plunge in the iron ore price, Mr Boyton said Deutsche’s iron ore/AUD pressure index was not yet at levels that had in the past seen verbal intervention from the RBA (see chart).

“We also wouldn’t expect the Australian dollar to ‘automatically’ fall in response to lower iron ore prices unless the market prices a greater risk of rate cuts from the RBA.”

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